What Is Carry in Fixed Income and How Does It Work?

Fixed income investors seek predictable returns, and a key factor in those returns is “carry.” Carry represents the income earned from holding a bond or other fixed-income security over time, excluding price changes. It influences portfolio strategy and investment decisions across different maturities and market conditions.

Understanding carry helps investors assess risk and return trade-offs, particularly when considering interest rate movements and funding costs.

Components of Carry in Fixed Income

Carry in fixed income comes from periodic interest payments, financing costs, and price adjustments over time. Each factor contributes to an investor’s overall return.

Coupon Payments

A bond’s coupon represents the periodic interest payments made to bondholders, typically on a semiannual basis in the U.S. The amount is determined by the bond’s coupon rate, set at issuance as a percentage of the bond’s face value. For example, a bond with a 5% annual coupon and a $1,000 face value pays $50 per year, split into two $25 payments if paid semiannually.

These payments form the primary source of carry for most fixed-income investors. Higher-coupon bonds offer greater carry but also come with reinvestment risk—the possibility that future interest payments will be reinvested at lower rates if yields decline. Investors compare a bond’s coupon to prevailing market rates to assess its attractiveness relative to newly issued securities.

Funding Rates

For investors using leverage, such as hedge funds or banks, financing costs affect carry. This is particularly relevant in repurchase agreements (repos), where investors borrow funds using bonds as collateral. The repo rate—the interest cost of borrowing—directly impacts net carry. If a bond’s yield exceeds financing costs, the position is profitable. If short-term rates rise above the bond’s yield, carry turns negative, meaning financing costs outweigh earnings.

Funding rates fluctuate with monetary policy, and central bank decisions on benchmark rates significantly impact the cost of carry. When the Federal Reserve raises interest rates, short-term borrowing costs increase, reducing the profitability of leveraged bond positions.

Price Adjustments

While carry primarily refers to income earned from holding a bond, price changes due to amortization or accretion also contribute. Bonds purchased at a discount to face value appreciate as they approach maturity, generating additional return. This process, known as accretion, increases a bond’s effective yield over time. Conversely, bonds bought at a premium decline in price as they near maturity, reducing overall carry.

For example, a bond purchased at $950 with a $1,000 face value gains $50 as it matures, adding to an investor’s return. Callable bonds introduce further complexity, as their price behavior depends on the likelihood of early redemption by the issuer, which can alter expected carry.

Carry in Different Bond Maturities

Carry varies based on a bond’s maturity, influencing interest income, reinvestment risk, and price behavior.

Short-Term Issues

Bonds with maturities of one to three years typically offer lower yields than longer-term securities but provide more predictable carry due to limited exposure to interest rate fluctuations. Since these bonds mature quickly, investors frequently reinvest proceeds into new issues, making reinvestment risk a key consideration. If interest rates decline, reinvesting at lower yields can reduce future carry.

Short-term bonds are also less sensitive to price volatility, meaning their carry is primarily derived from coupon payments rather than price adjustments. Investors seeking stable income with minimal duration risk favor short-term bonds, particularly in rising rate environments where reinvestment opportunities improve. Treasury bills, commercial paper, and short-term corporate bonds fall into this category.

Intermediate Notes

Bonds with maturities between four and ten years balance yield and stability, offering higher carry than short-term securities while maintaining moderate interest rate sensitivity. These bonds provide steady income through coupon payments, but their prices fluctuate as market rates change.

Investors holding intermediate-term bonds must consider both reinvestment and duration risk, as changes in interest rates impact both future income and bond valuations. Many corporate and government bonds fall into this category, making them a core component of diversified fixed-income portfolios.

The carry advantage of these bonds depends on the yield curve’s shape. When the curve is upward-sloping, intermediate bonds generally offer better carry than short-term alternatives. However, if the curve flattens, the additional yield may not justify the increased duration risk.

Long-Term Bonds

Bonds with maturities exceeding ten years offer the highest potential carry due to their elevated yields but also come with greater interest rate risk. Since these bonds lock in coupon payments for extended periods, they are more sensitive to market rate changes, leading to significant price fluctuations.

Carry in long-term bonds is primarily driven by coupon income, but price movements can substantially impact total returns. If interest rates decline, long-term bond prices rise, enhancing carry through capital appreciation. Conversely, rising rates erode carry by reducing bond values.

Callable long-term bonds introduce additional complexity, as issuers may redeem them early if rates fall, limiting investors’ ability to benefit from higher carry. Treasury bonds, municipal bonds, and corporate debt with extended maturities fall into this category.

Yield Curve Positioning

The shape of the yield curve plays a central role in determining how investors position their fixed-income portfolios to maximize carry. When the yield curve is upward-sloping—meaning longer-term bonds yield more than shorter-term ones—investors can enhance carry by extending duration and holding securities with higher yields. This approach works well in stable rate environments where the additional yield compensates for the risk of holding longer maturities.

However, when the curve flattens or inverts, shorter-term bonds may offer similar or even higher yields than long-term alternatives, making traditional carry strategies less effective. Investors adjust positioning based on expectations for future interest rates and economic conditions.

For example, if the Federal Reserve signals an extended period of stable rates, investors may take advantage of steep portions of the curve by holding intermediate-term bonds that offer a balance between yield and risk. Conversely, if rate cuts are anticipated, shorter-duration bonds may be preferable, as they can be reinvested at higher prices when yields decline.

Some investors use a barbell strategy, combining short- and long-term bonds to capture both liquidity and yield advantages while avoiding the middle of the curve. This approach is useful when the curve is flat, as intermediate-term bonds may not provide enough additional carry to justify their duration risk. Alternatively, a bullet strategy—concentrating holdings in a single maturity range—may be appropriate when specific yield curve segments offer superior carry opportunities.

Carry in Inflation-Linked Bonds

Inflation-linked bonds, such as Treasury Inflation-Protected Securities (TIPS) in the U.S. or index-linked gilts in the U.K., introduce a dynamic component to carry that differentiates them from nominal bonds. The principal value of these securities adjusts based on changes in an inflation index, typically the Consumer Price Index (CPI), meaning both interest payments and the final redemption amount fluctuate with inflation.

The real yield on inflation-protected securities determines carry, reflecting the return earned above inflation. Unlike nominal bonds, where carry comes primarily from fixed coupon payments, inflation-linked bonds generate income that varies over time.

When inflation accelerates, the adjusted principal increases, leading to higher interest payments and enhanced carry. However, in periods of disinflation or deflation, the carry advantage diminishes, as the principal adjustment mechanism can work in reverse, reducing future payouts. This variability makes assessing carry in inflation-linked bonds more complex, as it depends not only on prevailing yields but also on inflation trends and expectations embedded in market pricing.